The SEC's Latest Revolution

Ten years ago today, the Securities and Exchange Commission did something it had never done before. It finedXerox $10 million for accounting violations that overstated the company’s earnings by $1.5 billion over a period of years.

After the corporate scandals at Enron and the more recent financial crisis, the amounts involved seem trivial.

Yet at the time, the $10 million civil penalty set a record.

The outcry arising from the corporate scandals of that era ignited a revolution. Within a year of Xerox’s settlement, SEC penalties reached hundreds of millions of dollars.

As a similar outcry sweeps through the nation – and some of its courts – ten years later, the SEC is going through another revolution in how it calculates penalties. Completing that revolution, however, will require the agency to do more than acquire additional powers from Congress. The SEC will have to again reinvent itself as a regulator and watchdog – a process decades in the making.

History of SEC Penalties

During its first few decades of existence, the SEC viewed itself as benevolent disciplinarian that sought to “protect the public from fraudulent and other unlawful practices” but saw no need “to obtain damages for injured individuals.”

Up until the 1970s, the SEC rarely issued penalties or fines other than insider trading cases. Eventually, it began to disgorge ill-gotten gains but went no further.

None of this seemed unusual at the time: the New Deal era legislation that gave birth to the SEC and the securities laws under its provenance did not grant the agency the authority to extract such monetary payouts. Up until 1984, the agency’s authority to issue civil penalties limited it to assessing a penalty of $100 a day against companies that failed to file timely financial reports. Its limited use of disgorgement arose from a judicial remedy rather than a Congressional license.

The first major shift came in 1990 with the passage of the longwinded Securities Enforcement Remedies and Penny Stock Reform Act, thankfully truncated to the “Remedies Act” in common parlance. Amidst the wave of insider trading and other financial crimes of the era – remember Michael Milken and Ivan Boesky – Congress formally granted the SEC the power to seek monetary penalties for a broad array of securities violations.

Even then, Congress did not view penalties as a means of compensating victims but as a way to deter companies from wrongdoing.

Just as important, the SEC viewed monetary payouts as a zero-sum game for harmed investors: whatever funds a company coughed up to the agency would be unavailable to its injured shareholders. As a result, because all the monetary payments under the new law went to the government and not to injured investors, the agency remained reluctant to seek large sums.

In fact, the Remedies Act urged the SEC to target executives individually rather than seek large payouts from companies for this very reason.